Government Securities Clearing Corporation

Your letter of August 31, 2001 requests our concurrence with your view that the Government Securities Clearing Corporation ("GSCC") acts as a securities depository for purposes of Rule 17f-4 under the Investment Company Act of 1940 (the "1940 Act"), in connection with GSCC's clearance and settlement of U.S. government securities through the Interbank Mechanism, as described below.

FACTS

GSCC is registered with the Commission as a clearing agency under Section 17A of the Securities Exchange Act of 1934 (the "1934 Act"). GSCC operates the General Collateral Finance Repo Service ("GCF Repo Service")1 that allows certain members of GSCC ("GCF dealers") to engage in general collateral repurchase agreements ("general collateral repos") involving U.S. government securities without requiring immediate trade-for-trade settlement throughout the day. In a typical repurchase agreement, a buyer purchases U.S. government securities from a seller (a "counterparty") and agrees to resell those securities to the counterparty at a stated price at a later, agreed-upon date. Upon resale, the buyer receives the agreed-upon price, which includes an additional amount determined by the "repo rate" for the transaction. In a general collateral repo that is settled through GSCC, the buyer and its counterparty (which are both GCF dealers) do not specify the U.S. government securities that will serve as collateral for the repurchase agreement; rather, they permit the delivery of any one or more U.S. government securities represented by generic CUSIP numbers.2

The GCF Repo Service allows GCF dealers to enter in general collateral repos until the close of each trading day. After the close of each trading day (currently 3:35 p.m.), GSCC aggregates and matches trades to establish a single net settlement position and collateral allocation obligation or entitlement for each GCF dealer. Initially, GSCC permitted GCF dealers to engage in GCF repos only with other dealers that cleared their securities transactions at the same clearing bank because, at the end of the trading day, GSCC could not process transactions that involved different clearing banks after the Federal Reserve's electronic facility for the transfer of securities held in the FRB book-entry system (the "Fedwire") had closed.3 GSCC subsequently established a mechanism to allow GCF dealers to engage in general collateral repos with dealers that use different clearing banks (the "Interbank Mechanism").4 The Interbank Mechanism permits the movement of securities by bookkeeping entry between two clearing banks, The Bank of New York ("BONY") and The Chase Manhattan Bank ("Chase"), after the Fedwire has closed.5

To implement the Interbank Mechanism, each of BONY and Chase established a special securities clearance account on its books and records for the benefit of GSCC (the "BONY Account for GSCC," and the "Chase Account for GSCC," respectively). GSCC in turn established on its own books and records a securities clearance account for the benefit of Chase (the "GSCC Account for Chase"), and one for the benefit of BONY (the "GSCC Account for BONY").6 Under the Interbank Mechanism, at the end of each trading day, each of BONY and Chase seeks to make all necessary transfers of cash and collateral to the other clearing bank. The clearing bank that is in the net short position (e.g., BONY) and needs to move the U.S. government securities that serve as collateral to the clearing bank that is in the net long position (e.g., Chase) effects the movement of the collateral by transferring the collateral by bookkeeping entry into the BONY Account for GSCC. GSCC then transfers the collateral by bookkeeping entry to the GSCC Account for Chase. Chase then enters the collateral on its books for the benefit of GSCC and then, at GSCC's direction, transfers the collateral by bookkeeping entry to the appropriate GCF dealer(s).

You state that registered investment companies ("funds") would like to enter into general collateral repos with GCF dealers ("fund repos"), whereby a fund would purchase U.S. government securities from a GCF dealer and agree to resell those securities to the GCF dealer at a stated price at a later, agreed-upon date.7 In a fund repo, a single custodian, BONY or Chase as appropriate (the "tri-party repo custodian"),8 would act on behalf of both a fund and the GCF dealer that acts as counterparty in the fund repo.9 You state that BONY and Chase, acting as tri-party repo custodians, have established clearance accounts for the GCF dealers, and would establish a separate account for each fund that enters into a fund repo.

In connection with a fund repo, a GCF dealer would instruct the tri-party repo custodian to transfer the appropriate U.S. government securities from the account that the tri-party repo custodian maintains for the GCF dealer to the account that the tri-party repo custodian maintains for the fund. Under certain circumstances, at the end of a trading day, it may be necessary to transfer U.S. government securities into the GCF dealer's account with the tri-party repo custodian using the Interbank Mechanism. If a tri-party repo custodian was in the net long position after the Fedwire had closed, certain U.S. government securities would be transferred through the Interbank Mechanism to be booked to the GCF dealer's account. In that case, if a tri-party repo custodian transfers to a fund from a GCF dealer's account any U.S. government securities that were previously transferred through the Interbank Mechanism, GSCC could be deemed to have custody of the U.S. government securities that serve as collateral for the fund repo for purposes of Rule 17f-4 under the 1940 Act. In particular, GSCC may be deemed to have custody of any securities that settled through the BONY Account for GSCC or the Chase Account for GSCC, or through the GSCC Account for BONY or the GSCC Account for Chase.10

ANALYSIS

Section 17(f) of the 1940 Act sets forth the custodial requirements for funds and generally provides that, subject to rules adopted by the Commission, fund assets may be deposited in U.S. securities depositories. The Commission adopted Rule 17f-4 under the 1940 Act, which permits a fund or its custodian, subject to certain conditions in the rule, to deposit the fund's assets in U.S. securities depositories. Paragraph (a) of Rule 17f-4 defines a "securities depository" as:

a system for the central handling of securities where all securities of any particular class or series of any issuer deposited within the system are treated as fungible and may be transferred or pledged by bookkeeping entry without physical delivery of the securities.

Paragraph (b)(1) of Rule 17f-4 permits a fund or its custodian to deposit all or part of the securities owned by the fund in a clearing agency that is registered with the Commission under Section 17A of the 1934 Act (a "registered clearing agency") and that acts as a securities depository.

You assert that GSCC acts as a securities depository, as defined in Rule 17-4, with respect to the U.S. government securities that clear and settle through the Interbank Mechanism. We agree, based on the following facts and representations: (i) GSCC is a registered clearing agency that must have its rules governing the GCF Repo Service and the Interbank Mechanism approved by the Commission;11 (ii) GSCC serves as a system for the central handling of the U.S. government securities that clear and settle through the Interbank Mechanism; (iii) the U.S. government securities that clear and settle through the Interbank Mechanism are "deposited within" GSCC, within the meaning of Rule 17f-4;12 and (iv) GSCC treats as fungible, and transfers or pledges by bookkeeping entry without physical delivery, all of the U.S. government securities that clear and settle through the Interbank Mechanism.

You state that GSCC established standardized generic CUSIP numbers exclusively for GCF Repo Service processing. You state further that the generic CUSIP numbers are used to specify the acceptable types of underlying collateral, and are not the same CUSIP numbers utilized in connection with the Federal Reserve Bank's book-entry securities account maintenance and transfer system for certain U.S. government and agency securities ("FRB book-entry system").

You state that U.S. government securities are transferred in book-entry form through the Fedwire, which closes each business day at 3:30 p.m. You represent that GSCC initially permitted GCF dealers to engage in general collateral repos only with GCF dealers that used the same clearing bank because, at the end of each trading day, GSCC could net the dealers' positions and the clearing banks could transfer collateral between a buyer and counterparty's accounts within the clearing bank by book-entry, without using the Fedwire.

You state that the Commission approved the use of the Interbank Mechanism under Section 19(b)(1) of the 1934 Act to facilitate the clearance and settlement of trades executed through the GCF Repo Service. SeeSelf-Regulatory Organizations; Government Securities Clearing Corporation, Securities Exchange Act Release Nos. 41022 (Feb. 5, 1999) (notice) and 41303 (April 16, 1999) (order) (the "Interbank Mechanism Order").

You represent that each of the BONY Account for GSCC, the Chase Account for GSCC, the GSCC Account for BONY, and the GSCC Account for Chase is a securities account as defined in Article 8 of the New York Uniform Commercial Code ("NYUCC"). You state that, accordingly, BONY and Chase are "entitlement holders" having "securities entitlements" against GSCC in its capacity as a "securities intermediary" (in each case as such term is defined in Article 8 of the NYUCC) with respect to the securities that are credited by GSCC to the GSCC Account for BONY and the GSCC Account for Chase, respectively. In addition, you state that GSCC is an "entitlement holder" having "securities entitlements" against BONY and Chase in each of their capacities as "securities intermediary" with respect to the securities that are credited by BONY to the BONY Account for GSCC and by Chase to the Chase Account for GSCC, respectively. You state that GSCC has appointed Chase as its agent to maintain GSCC's books and records with respect to the GSCC Account for BONY, and that GSCC has appointed BONY to maintain GSCC's books and records with respect to the GSCC Account for Chase.

In general, a fund maintains the securities that collateralize its repurchase agreements with the fund's custodian, or an entity that qualifies as a custodian under the 1940 Act. See The Investment Company Institute (pub. avail. June 15, 1999).

You represent that BONY and Chase are eligible fund custodians pursuant to Section 17(f)(1) of the 1940 Act. See Section 17(f)(1), which provides that a fund may place and maintain its securities and similar investments in the custody of a bank or banks having the qualifications prescribed in paragraph (1) of Section 26(a) of the 1940 Act.

See the GCF Repo Service Order and the Interbank Mechanism Order, supra notes 1

and 4. We note that Section 17A(b)(3)(F) of the 1934 Act requires that the rules of a clearing agency be designed to, among other things, ". . . assure the safeguarding of securities and funds which are in the custody or control of the clearing agency or for which it is responsible . . . ." The Commission stated in the Interbank Mechanism Order that it believes that:

. . . the procedures and arrangements GSCC has established for the movement between GSCC's clearing banks of securities and funds related to GCF Repo transactions should help to assure the safeguarding of securities and funds which are in GSCC's custody or control or for which it is responsible.

You acknowledge that the U.S. government securities are "deposited within" the FRB book-entry system by the clearing banks within the meaning of Rule 17f-4. You maintain, however, that the U.S. government securities that clear and settle through the Interbank Mechanism also are "deposited within" GSCC.

Re: Designation of GSCC as a Securities Depository
for Operation of Interbank Mechanism

Dear Mr. Scheidt:

We are writing on behalf of our client, Government Securities Clearing Corporation ("GSCC"), to request your concurrence with our view that GSCC acts as a securities depository for purposes of Rule 17f-4 under the Investment Company Act of 1940 (the "1940 Act"), in connection with GSCC's clearance and settlement of U.S. government securities through the Interbank Mechanism, as described below.

I. Background

GSCC is registered with the Securities and Exchange Commission (the "Commission") as a clearing agency under Section 17A of the Securities Exchange Act of 1934 (the "1934 Act"). GSCC operates the General Collateral Finance Repo Service ("GCF Repo Service"),1 which allows certain members of GSCC ("GCF dealers") to engage in general collateral repurchase agreements ("general collateral repos") involving U.S. government securities without requiring trade-for-trade settlement.

In a typical repurchase agreement, a buyer purchases U.S. government securities from a seller (a "counterparty") and agrees to resell those securities to the counterparty at a stated price at a later, agreed-upon date. Upon resale, the buyer receives the agreed-upon price, which includes an additional amount determined by the "repo rate" for the transaction. In a general collateral repo settled through GSCC, the buyer and its counterparty (which are both GCF dealers) do not specify the U.S. government securities that will serve as collateral for the repurchase agreement; rather they permit the delivery of any one or more securities represented by generic CUSIP numbers.2

The GCF Repo Service allows GCF dealers to enter into general collateral repos until the close of each trading day without requiring immediate trade-for-trade settlement throughout the day. After the close of each trading day (currently 3:35 p.m.), GSCC aggregates and matches trades to establish a single net settlement position and collateral allocation obligation or entitlement for each GCF dealer. Initially, GSCC permitted GCF dealers to engage in GCF repos only with other dealers that cleared their securities transactions at the same clearing bank because at the end of the trading day, GSCC could not process transactions that involved different clearing banks after the Federal Reserve System's electronic facility for the transfer of securities held in the FRB book-entry system (the "Fedwire") had closed.3 GSCC subsequently established a mechanism to allow GCF dealers to engage in general collateral repos with dealers that use different clearing banks (the "Interbank Mechanism").4 The Interbank Mechanism permits the movement of securities by bookkeeping entry between two clearing banks, The Bank of New York ("BONY") and The Chase Manhattan Bank ("Chase"), after the Fedwire has closed.5

To implement the Interbank Mechanism, each of BONY and Chase established a special securities clearance account on its books and records for the benefit of GSCC (the "BONY Account for GSCC," and the "Chase Account for GSCC," respectively). GSCC in turn established on its own books and records a securities clearance account for the benefit of Chase (the "GSCC Account for Chase"), and one for the benefit of BONY (the "GSCC Account for BONY").6 Under the Interbank Mechanism, at the end of each trading day, each of BONY and Chase seeks to make all necessary transfers of cash or collateral to the other clearing bank. The clearing bank that is in the net short position (e.g., BONY) and needs to move the U.S. government securities that serve as collateral to the clearing bank that is in the net long position (e.g., Chase) effects the movement of the collateral by transferring the collateral into the BONY Account for GSCC. GSCC then transfers the collateral by bookkeeping entry to the GSCC Account for Chase. Chase then enters the collateral on its books for the benefit of GSCC and then, at GSCC's direction, transfers the collateral to the appropriate GCF dealer(s).

Registered investment companies ("funds") would like to be able to utilize the Interbank Mechanism to facilitate day-to-day collateral transfers for their general collateral repos with GCF dealers ("fund repos"). In a fund repo, a fund purchases U.S. government securities from a GCF dealer and agrees to resell those securities to the GCF dealer at a stated price at a later, agreed-upon date. A single custodian, BONY or Chase as appropriate (the "tri-party repo custodian"),7 acts on behalf of both the fund and the GCF dealer that is the counterparty in the fund repo.8 BONY and Chase, acting as tri-party repo custodians, have established clearance accounts for the GCF dealers and establish a separate account for each fund that enters into a fund repo.

In the administration of a fund repo, a GCF dealer instructs the tri-party repo custodian each trading day to transfer the appropriate U.S. government securities from the account that the tri-party repo custodian maintains for the GCF dealer to the account that the tri-party repo custodian maintains for the fund.

When funds gain the ability to utilize the Interbank Mechanism, if the tri-party repo custodian were in the net long position in connection with the GCF Repo Service after the Fedwire had closed, certain U.S. government securities would be transferred through the Interbank Mechanism. If the tri-party repo custodian were to transfer any securities that were previously transferred through the Interbank Mechanism to a fund to satisfy the delivery instructions of a GCF dealer in connection with a tri-party repo, GSCC could be deemed to have custody of the U.S. government securities that serve as collateral for the fund repo for purposes of Rule 17f-4 under the 1940 Act. In the BONY-Chase example, GSCC may be deemed to have custody of any securities that settled through the GSCC Account for Chase.9

II. Analysis

Section 17(f) of the 1940 Act sets forth the custodial requirements for funds and generally provides that, subject to rules adopted by the Commission, fund assets may be deposited in U.S. securities depositories. The Commission adopted Rule 17f-4 under the 1940 Act, which permits a fund or its custodian, subject to certain conditions in the rule, to deposit the fund's assets in U.S. securities depositories. Paragraph (a) of Rule 17f-4 defines a "securities depository" as:

a system for the central handling of securities where all securities of any particular class or series of any issuer deposited within the system are treated as fungible and may be transferred or pledged by bookkeeping entry without physical delivery of the securities.

Paragraph (b)(1) of Rule 17f-4 permits a fund or its custodian to deposit all or part of the securities owned by the fund in a clearing agency that is registered with the Commission under Section 17A of the 1934 Act (a "registered clearing agency") and that acts as a securities depository.

We believe that GSCC acts as a securities depository, as defined in Rule 17-4, with respect to the U.S. government securities that clear and settle through the Interbank Mechanism, based on the following facts and representations: (i) GSCC is a registered clearing agency that must have its rules governing the GCF Repo Service and the Interbank Mechanism approved by the Commission;10 (ii) GSCC serves as a system for the central handling of the U.S. government securities that clear and settle through the Interbank Mechanism; (iii) the U.S. government securities that clear and settle through the Interbank Mechanism are "deposited within" GSCC within the meaning of Rule 17f-4;11 and (iv) GSCC treats as fungible, and transfers or pledges by bookkeeping entry without physical delivery, all of the U.S. government securities that clear and settle through the Interbank Mechanism.

III. Conclusion

For the foregoing reasons, we respectfully request that the staff concur with our view that GSCC acts as a securities depository for purposes of Rule 17f-4 under the 1940 Act, in connection with GSCC's clearance and settlement of U.S. government securities through the Interbank Mechanism.

* * *

We would appreciate consideration of this matter as promptly as practicable. If for any reason the staff is not disposed to grant the requested no-action relief, we would also appreciate an opportunity to discuss the situation with the staff prior to the issuance of any formal letter. Questions regarding this no-action request should be directed to the undersigned (at 202-974-1888), Brent E. Binge (at 202-974-1668) or Diane E. Waller, GSCC Deputy General Counsel (at 212-855-7632).

GSCC established standardized generic CUSIP numbers exclusively for GCF Repo Service processing. The generic CUSIP numbers are used to specify the acceptable types of underlying collateral, and are not the same CUSIP numbers utilized in connection with the Federal Reserve Banks' book-entry securities account maintenance and transfer system for certain U.S. government and agency securities ("FRB book-entry system").

U.S. government securities are transferred in book-entry form through the Fedwire, which currently closes each business day at 3:30 p.m. GSCC initially permitted GCF dealers to engage in general collateral repos only with GCF dealers that used the same clearing bank because, at the end of each trading day, GSCC could net the dealers' positions and the clearing banks could transfer collateral between a buyer and counterparty's accounts within the clearing bank by book-entry, without using the Fedwire.

Each of the BONY Account for GSCC, the Chase Account for GSCC, the GSCC Account for BONY, and the GSCC Account for Chase is a securities account as defined in Article 8 of the New York Uniform Commercial Code ("NYUCC"). Accordingly, BONY and Chase are "entitlement holders" having "securities entitlements" against GSCC in its capacity as a "securities intermediary" (in each case as such term is defined in Article 8 of the NYUCC) with respect to the securities that are credited by GSCC to the GSCC Account for BONY and the GSCC Account for Chase, respectively. Similarly, GSCC is an "entitlement holder" having "securities entitlements" against BONY and Chase in each of their capacities as "securities intermediary" with respect to the securities that are credited by BONY to the BONY Account for GSCC and by Chase to the Chase Account for GSCC, respectively.

GSCC has appointed Chase as its agent to maintain GSCC's books and records with respect to the GSCC Account for BONY, and GSCC has appointed BONY to maintain GSCC's books and records with respect to the GSCC Account for Chase.

In general, a fund maintains the securities that collateralize its repurchase agreements with the fund's custodian, or an entity that qualifies as a custodian under the 1940 Act. See The Investment Company Institute (pub. avail. June 15, 1999).

BONY and Chase are eligible fund custodians pursuant to Section 17(f)(1) of the 1940 Act. See Section 17(f)(1), which provides that a fund may place and maintain its securities and similar investments in the custody of a bank or banks having the qualifications prescribed in paragraph (1) of Section 26(a) of the 1940 Act. In a fund repo involving use of the Interbank Mechanism, the specific securities constituting the underlying collateral held for the benefit of the fund would continue to be identified on the tri-party repo custodian's books by their individual CUSIP numbers so as to enable the fund repo to be "collateralized fully" as defined in Rule 5b-3(c)(2) under the 1940 Act.

See the GCF Repo Service Order and the Interbank Mechanism Order, supra notes 1 and 4. We note that Section 17A(b)(3)(F) of the 1934 Act requires that the rules of a clearing agency be designed to, among other things, "...assure the safeguarding of securities and funds which are in the custody or control of the clearing agency or for which it is responsible..." The Commission stated in the Interbank Mechanism Order that it believes that:

... the procedures and arrangements GSCC has established for the movement between GSCC's clearing banks of securities and funds related to GCF Repo transactions should help assure the safeguarding of securities and funds which are in GSCC's custody or control or for which it is responsible...

U.S. government securities are "deposited within" the FRB book-entry system by the clearing banks within the meaning of Rule 17f-4. However, U.S. government securities that clear and settle through the Interbank Mechanism also are "deposited within" GSCC.